For Employers, Pay-or-Play Proposals Could Be Worse, Much Worse

Could employee benefits regulatory activity under the Patient Protection and Affordable Care Act (Act) be taking a turn toward common sense?

Based on the new proposed rules on the “pay-or-play” provision under the Act—only those on the federal payroll still say “shared responsibility”—the answer may be a qualified “yes.” (The “pay-or-play” mandate refers to an employer’s option under the Act to provide the required coverage to all full-time employees (play) or pay penalty taxes for not offering coverage (pay).)

Published in the Federal Register on Jan. 2, the proposals represent the latest attempt by the Internal Revenue Service (IRS) to put into effect the requirements of Internal Revenue Code (Code) section 4980H. Code section 4980H was added by the Act and requires large employers to offer minimum essential coverage to “full-time employees” and their “dependents.” Failure to offer such coverage would trigger a penalty tax if any full-time employee is not offered such coverage, applies for coverage through one of the public insurance exchanges set to come online in 2014, and qualifies for federal financial aid for that coverage. Those penalty taxes differ depending on whether an employer failed to offer any minimum essential coverage or whether it failed to offer coverage that was “affordable” and provided “minimum value” under federal standards.

Here is a recap of some of the highlights of the proposed rules:

“Pay-or-play” penalties under Code section 4980H would be applied separately to each member of a controlled group, rather than on a controlled group-wide basis. This represents good news, for example, where some subsidiaries of a parent company may want to “play” (that is, provide coverage), while others “pay” the relevant penalty taxes. Note that these proposed rules would not affect other legal rules that may hinder employer plans to provide benefits for only certain subsidiaries.

For purposes of the pay-or-play requirements, “dependents” would be children as defined in Code section 152(f)(1). This definition includes step-children and foster children, but it does not include other dependents such as spouses or domestic partners. The proposed rules also contain a transition rule for employers that do not currently offer dependent coverage.

The “affordability” standards under Code section 4980H may in several ways be easier to meet than might have been expected. Consistent with prior IRS guidance, the proposed rules appear to let employers evaluate affordability on the basis of self-only coverage, even in cases where an employee covered his or her family. The proposed rules also contain three design-based safe harbors that would enable employers to meet the affordability standard by setting employee costs for self-only coverage based on W-2 wages, the federal poverty level, or an employee’s rate of pay.

Under the statute, if even one full-time employee of a large employer was not offered coverage, applied for coverage through a new insurance exchange, and qualified for federal aid for that coverage, an employer would face a penalty of $2,000 per full-time employee in its workforce (minus the first 30). This would be true even if every other full-time employee had properly been offered coverage. Under a de minimis standard in the proposed rules, no penalty would apply where an employer had properly offered coverage to at least 95 percent of its full-time employees. Here again, this standard typically would apply separately to each member of a controlled group, rather than on a controlled group-wide basis.

The safe harbor that the IRS has gradually developed for employers to evaluate full-time status across a workforce features “measurement” periods to gauge how many hours an employee works and then “stability” periods during which the employee would be characterized as full-time or not full-time. This approach is clearly ill-suited to educational institutions that run regularly on an academic year, and the new proposed rules contain special provisions designed to adapt the safe harbor to that industry.

All this is not to say that the proposed rules are ideal. The rules to evaluate which employees are full-time remain frustratingly complex. And the rules governing which employers are “large” employers will put a burden on small employers that often lack compliance resources.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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